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Global Emerging Markets 2018 Outlook

Emerging markets have had a very strong 12 months, driven by a confluence of factors. Here, Kim Catechis outlines why the structural backdrop remains so attractive going into 2018.

11 January 2018

What were the key drivers of markets last year?

Emerging markets enjoyed a spectacular year in 2017, driven by a combination of factors, including a strong earnings recovery, relatively stable currencies, strengthening economic growth and trade, as well as a generally benign start to the US Federal Reserve’s (Fed) upward interest rate cycle. These positive influences essentially overrode the challenges and uncertainties arising from a widespread phenomenon of political realignment and geopolitical tensions. In many countries, such as Brazil and South Africa, the uncovering of wideranging corruption scandals in public sector procurement have led to the destruction of long-standing political party structures – a necessary precursor to the establishment of good governance.

Global Emerging Markets Q1 2018 Outlook

Kim Catechis gives his views

Did your strategy perform as you would have expected in 2017?

Against a backdrop of excellent returns for the asset
class as a whole in 2017, the portfolio performed
strongly in both absolute and relative terms over the
course of the year, as the companies held generally
delivered above market expectations. Overall, the
biggest gains came from the portfolio’s positions in
consumer discretionary, financials and technology, all
three benefiting from the growth of the middle-income
consumer in emerging markets. There were only two
sectors where we had negative relative returns –
industrials and real estate.*

What do you think will be the key drivers for your markets in 2018?

Technology will remain a prominent driver in emerging
markets, with the rapid development of new applications
creating significant business opportunities, while also
challenging companies that are slow to adapt. The
increasing weight, in economic and political terms, of
the new entrants to the middle income group in each
country will continue to be a strong theme, benefiting
consumer trends. Meanwhile, we expect to see a
continued drive to improve governance in domestic
politics which will shape economic policy. Not to forget the exponential growth in trade between emerging
market countries – often overlooked amid all the talk of
rising global protectionism – which provides a very
supportive backdrop for growth. Finally, the higher
priority given to environmental considerations (such as
China’s focus on clean air and water) will drive further
development of non-polluting technologies such as
electric vehicles and renewable energy.

Technology will remain
a prominent driver in
emerging markets, with
the rapid development of
new applications creating
significant business
opportunities, while also
challenging companies that
are slow to adapt.

How are earnings revisions and valuations looking relative to historic averages and other markets?

It is clear from the 2017 third-quarter earnings that the
asset class has marginally outperformed the markets
expectations for earnings growth for the year, driven by
the technology, consumer staples and materials sectors.†
In terms of disappointments, the telecommunications
sector featured high, driven in no small measure by the
wireless subsector, where results missed analysts’
expectations.

From a valuation perspective, the asset class currently
stands at a 12-month forward price-to-earnings ratio of
around 12.4x, which is above the 10-year average of 11x.†
However, we should not forget that the nature of the
asset class has changed – the technology weighting in
the index and the reduction of the materials and energy
sector imply that the structural level of return on equity
(ROE) will be higher than in the past, and the level of
debt to equity will be lower, thus justifying a significantly
higher median valuation for the asset class.

What are the biggest risks to your markets in 2018?

An obvious risk is the possibility of an escalation of
tensions on the Korean Peninsula, with outright war the
most extreme scenario. Needless to say, this would
affect global – and not just emerging – markets. In the
economic realm, there’s an outside chance a sharp rise
in inflation in the US, leading to a faster-than-expected
increase in interest rates by the Fed, could cause some
volatility in emerging markets. There’s also the worry
that Chinese economic growth takes a nosedive – the
‘hard landing’ that has been talked about for years, but
not materialised. Importantly, we assign very small
probabilities to all of these outcomes.

What sustainability themes do you see yourself engaging with companies on most in 2018?

We will continue to engage with companies on any
material environmental, social and governance (ESG)
issues we identify, which of course can vary a great deal
from company to company. We know from experience
that improvements in these areas don’t come from
short, sharp battles. Rather, lasting improvements tend
to require many years of consistent and patient
engagement with management. In terms of the types of
themes we would expect to see more often, we would
point to governance, especially in the areas of board
composition and disclosure. Elsewhere, we also foresee
important areas such as climate change and
cybersecurity featuring high in our engagement. In the
case of the former, we want companies to evidence that
they are thinking not just about operational
consequences from threats like extreme weather and
water scarcity, but also about the strategic opportunities
presented by decarbonisation.

We will continue to engage with
companies on any material environmental,
social and governance (ESG) issues we
identify, which of course can vary a great
deal from sector to sector. We know from
experience that improvements in these
areas don’t come from short, sharp
battles.

*Source: Martin Currie over 12 months to 31 December 2017 in US$. All data presented is the representative Martin Currie Global Emerging Markets account. Data is presented net of
investment advisory fees, broker commissions, and all other expenses borne by investors. An annual fee rate of 0.70% has been applied for the net data. MSCI Emerging Markets index
used as benchmark. Relative calculation is geometric and stock performance is taken from the representative account.†Source: FactSet, as at 15 December 2017.

Important information

Past performance is not a guide for future returns

Investors should also be aware of the following risk
factors which may be applicable to the strategy.
Investing in foreign markets introduces a risk where
adverse movements in currency exchange rates could
result in a decrease in the value of your investment.
Emerging markets or less developed countries may
face more political, economic or structural challenges
than developed countries. Accordingly, investment in
emerging markets is generally characterised by higher
levels of risk than investment in fully developed markets.
For Investors in the USA, the information contained
within this document is for Institutional Investors only
who meet the definition of Accredited Investor as
defined in Rule 501 of the United States Securities Act
of 1933, as amended (‘The 1933 Act’) and the definition
of Qualified Purchasers as defined in section 2 (a) (51)
(A) of the United States Investment Company Act of
1940, as amended (‘the 1940 Act’). It is not for intended
for use by members of the general public.
Any distribution of this material in Australia is by Martin
Currie Australia (‘MCA’). Martin Currie Australia is a
division of Legg Mason Asset Management Australia
Limited (ABN 76 004 835 849). Legg Mason Asset
Management Australia Limited holds an Australian
Financial Services Licence (AFSL No. AFSL240827)
issued pursuant to the Corporations Act 2001.

This information is issued and approved by Martin
Currie Investment Management Limited (‘MCIM’). It
does not constitute investment advice.
Market and currency movements may cause the capital
value of shares, and the income from them, to fall as well
as rise and you may get back less than you invested.
The document may not be distributed to third parties
and is intended only for the recipient. The document
does not form the basis of, nor should it be relied
upon in connection with, any subsequent contract or
agreement. It does not constitute, and may not be used
for the purpose of, an offer or invitation to subscribe
for or otherwise acquire shares in any of the products
mentioned.
The information contained has been compiled with
considerable care to ensure its accuracy. However,
no representation or warranty, express or implied, is
made to its accuracy or completeness. Martin Currie
has procured any research or analysis contained in this
document for its own use. It is provided to you only
incidentally and any opinions expressed are subject to
change without notice.
The information provided should not be considered
a recommendation to purchase or sell any particular
security. It should not be assumed that any of the
security transactions discussed here were or will prove
to be profitable.
The opinions contained in this document are those
of the named manager(s). They may not necessarily
represent the views of other Martin Currie managers,
strategies or funds.

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Martin Currie has been investing in dedicated GEMs portfolios since 1991. We believe we have one of the most experienced GEMs teams in the industry, with a disciplined and repeatable long-term investment approach that is globally competitive.

Issued in the United Kingdom by Martin Currie Investment Management Limited. Authorised and regulated by the Financial Conduct Authority (c) 2017 Martin Currie Ltd. Martin Currie Investment Management Limited & Martin Currie Inc. are both registered as an Investment Advisor with the US Securities and Exchange Commission.

The information contained in this website does not constitute an offer of, or an invitation to apply for securities in any jurisdiction where such an offer or invitation is unlawful, or in which the person making such an offer is not qualified to do so.